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Use ETFs to help diversify your portfolio

By Edited May 4, 2016 0 0

When trying to get your portfolio balanced with the right asset allocation and diversification, it can become a little daunting to try and follow companies whose products or services are outside of what you know, some of the well known investors like Warren Buffett say that you should "Invest in what you know" but there is a small problem with this. What if what you know stops your portfolio from being well diversified? This means that you are taking on extra risk, because something in your known industries could go terribly wrong and your stocks will fall along with it. There are a few options you can take to make sure you stay well diversified; You can take the time to learn about these other industries which would allow you to make informed investing decisions. You could just invest in them and hope all goes well or you can choose to invest in an ETF (Exchange Traded Fund) or Index fund and let the professionals take care of that part of your portfolio.

I am not going to go into the details of what an ETF is, but they are essentially mutual funds that are traded like stocks. This will allow you to save on fees compared to mutual funds, because you pay a lower MER (Managerial Expense Ratio) and you still get all the benefits of a broad market exposure. The trade off is you have to buy it as if it were just like a normal stock, so you will be paying your broker for the transaction fees.

As much as we like to do it all ourselves and own individual shares, sometimes its best to take a step back and separate the industries or weightings into areas that you want to actively follow (or semi-actively) Vs the ones that you know you should have assets allocated to, but you don't feel you have enough knowledge of to make an informed decision.

When buying multiple ETFs you want to make sure that there is no (or very little) crossover between them. If you buy two ETFs that own the same shares then you aren't really diversifying are you? You'll most likely end up with a higher weighting then you wanted and hence, an unbalanced portfolio. So make sure you take a look at the ETF's constituents list, and see if you already own any of the individual shares, or if they are constituents in another ETF you have your eye on.

For an example, one of the ETF classes that I like to keep in my portfolio is a Bond ETF, this gives me access to a large basket of bonds without having to own individual contracts. This spreads the risk out nicely and still gives me that comfort of a steady income stream in my portfolio. An International ETF is another one that I like to keep in my portfolio becuase this gives me exposure to whats happening in the world outside of my country.

When it comes to diversification, you might not always be able to achieve your desired weightings if you were to do it yourself by buying individual stocks, so your next best option is to look into low cost ETFs to cover your bases. Remember that risk management and proper asset allocation is a very important part of investing, so always weigh your options and take any advantage you can get which sometimes means buying ETFs to get broad exposure to markets or industries that you don't want to keep your full attention on.



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